Starbucks Rewards Debate Missing A Key Ingredient: Flexibility

Summary

Starbucks commentators suggest the new rewards system will alienate many customers.

The new system offers the company more flexibility in how it targets customers and promotes certain products.

Overall, the flexibility provides a long-term advantage many are overlooking.

After Starbucks (NASDAQ: SBUX) announced its new rewards program In late February I was quick to defend it, pointing out that the company benefited on numerous fronts. I wrote, Starbucks has "more flexibility in running rewards promotions, expanding margins (though many have pointed to this, it is likely too soon to prove this point entirely), ability to incentivize higher ticket orders, and opportunity to demonstrate that they listen to consumer suggestions."

For those still unfamiliar with the new Starbucks reward system, the company implemented a switch from a one-star per transaction reward system that offered a free drink every 12 transactions to one that offers two-stars-per-dollar-spent, effectively rewarding a customer with a free drink after they spend $62.50 at Starbucks.

I have already broken down the dynamics of the switch from both a consumer and business perspective in my February article, so today I am instead focused on where the debate has transitioned to and how debaters are missing out on the flexibility the new system offers Starbucks.

The debate has shifted away from the advantages and disadvantages for all parties involved and narrowed in on whether or not small-ticket customers will be alienated from the brand and switch to a competitor. Surely this is the case for some customers, as evidenced by a few Seeking Alpha commentators who have declared the end of their allegiance to Starbucks, but it is not the case overall as the new system offers greater incentives for choosing Starbucks than before.

The new system can do this because the greater amount of stars affords Starbucks more flexibility in how it targets customers. Before, the company was limited by the 12-star system in that offering double or triple stars too often could eat away at margins while only delighting some customers.

What this means is that if the company has information that suggests a certain time will have low traffic, they can offer double, or even triple stars. Through doing this the company can encourage traffic, bringing back in low-dollar or spontaneous traffic who see the incentive in their email.

I originally speculated that the higher amount of total stars would give the company more flexibility, but Starbucks' actions since have proven it to be a clairvoyant forecast:

Starbucks has not just limited promotions to dealing with the number of stars, however. The company has also offered high star bonuses for purchasing specific items. Although this is not a new move, the high amount of stars offered with it can help to provide the psychological acceptance of the new rewards system:

The specific promotion above enables the company to drive breakfast sandwich sales over the long-term by incentivizing customers to give them a try while also helping customers reach that reward much sooner. This is flexibility at work.

Still, the aforementioned breakfast sandwich promotion may do little to promote low-dollar spenders at the expense of incentivizing high-dollar spenders to spend even more. Though the old business adage of "about 20 percent of your customers produce 80 percent of your sales" may apply here, as Starbucks is focusing in on getting their deep pocket spenders to reach even deeper, they have not given up on the low-dollar spenders, as evidenced by the Triple Star Promotion.

In fact, upon checking my email last week I saw this:

A breakfast sandwich, free of charge. This wasn't a reward and it wasn't a birthday gift. It was simply the company trying to get me to come into the store. Promotions such as this one allow the company to continue to drive the smaller-dollar spenders, even if the new rewards program makes it more difficult to them to earn rewards absent of bonuses.

That is the beauty of the new Starbucks system, it allows the company to be an information company that happens to sell coffee. It can utilize rewards data to understand what is happening with their customers and respond accordingly.

The change to the system enables the company to exploit this information to a greater extent by offering flexibility in offering large, customized star bonuses that drive traffic. For example, before if the company wanted to drive breakfast sandwich sales they could offer maybe three or four stars.

Though 25 or 33% of the way to a reward under the old system, the psychological benefit of three stars may have not been enough to encourage that at-the-margin purchase. Starbucks can now offer anywhere from 25-50 bonus stars for the same transaction, which may be more psychologically effective in driving larger purchases.

This same information will support Starbucks in figuring out ways to keep the lower-dollar traffic as well, as the double and triple bonus star promotions can be aimed towards specific target customers. The system is not as binary as prevailing wisdom may have you believe: there are ways to reach a reward without spending $62.50, and there are added benefits along the way.

Overall, there is always resistance to change. But over the long-term Starbucks has positioned itself to have more flexibility in how it attracts and retains great customers and in how it utilizes its information edge.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am a part-time barista at a licensed Starbucks store, all opinions are my own.